Enron Stakeholders

BA 215 Spring 2007

Enron Stakeholder Assignment

Enron was a dream come true for a lot of people, but it was also a nightmare waiting to happen for many more. I am going to examine the collapse of Enron from the management perspective. The three examples of Enron behaving badly that I am going to study are the incidents in Valhalla, the electricity trading in California and the conflict of interest between Andy Fastow and his special purpose entities (SPE). These are just a few cases that led to the failure of the "World's Leading Company."

In 1985 Houston Natural Gas merged with InterNorth, of Omaha, Neb., to form Enron and Ken Lay was named chief executive officer. The company was basically a producer of natural gas and had control over enormous reserves throughout the oil belt. The Valhalla trading scandal was the beginning of the end for Enron. Enron acquired the Valhalla trading group through the merger. Valhalla did not produce oil, but bought and sold oil futures. It bought oil long if it thought the market would rise and short if it thought oil prices would fall (2). In January 1987, a security officer at Apple Bank in New York alerted Enron auditors of a strange set of transactions by two of the company's oil traders: Louis Borget and Thomas Mastroeni. The bank security man said that $100,000 transfers were coming from an Enron account at Standard Chartered Bank in Britain's Channel Islands. Transactions from the Channel Islands were a red flag to bank security men because the islands are a source of secret offshore bank accounts and frequently the address of convenience for firms of suspicious character. The transfers, signed by Mastroeni, came from a U.S. Enron account, then went to the Channel Islands and then landed in an account opened by Mastroeni at Apple. Stated simply, Borget and Mastroeni seemed to be writing checks to themselves (2). This new information was hard for Ken Lay to swallow for a number of reasons. First of all, the Valhalla trading company was bringing in profits of $30 million a year, which accounted for one-third of Enron's earnings. The trading company was also off-setting the bleak natural gas prices. Finally, Ken Lay, along with COO Rich Kinder and a few internal auditors made a trip to New York to investigate the trading group. Within a short time of investigating, auditors stated that foul play had occurred (1 p31). Mastroeni and Borget explained the transactions with an absurd story to carry their enormous profits from 1986 into 1987 so as to start the year with a positive balance on the company books. Enron had exceeded its budget estimate for 1986, they said, and they created the Apple account to move money to 1987. The traders got caught in cooking the books; they were keeping two sets of accounting books, one was legitimate for Author Anderson and the other recorded the real transactions (1 p31). At this point Ken Lay had the chance to do the right thing and get rid of the greedy, law-breaking traders. Instead he limited the traders' power and called for a reform, which is visible today, did not happen according to plan.

The California energy crisis in 2001 left the state in chaos and in the dark. Enron convinced the state to deregulate electricity which would save billions of dollars a year, but would ultimately cost the state far more. The energy crisis of early 2001 forced the state to solve its rolling-blackout problem by signing a $40 billion in long-term energy contracts, the cost of which was passed on to consumers on a sliding scale. Electricity bills in 2002 were as much as 67% higher than in 2000 (3). It all started in 1996 when the state, under then Governor Pete Wilson, lobbied by Enron and other energy companies, decided to loosen its hold on electricity production. Responsibility for matching supply and demand was handed over in 1998 to an Independent System Operator (ISO), which would buy from providers, like Enron. Then the energy would be sold to middlemen, companies like Pacific Gas & Electric, as needed, even paying providers to take surplus electricity out of the state (3). The theory of deregulation of electricity in California was a model one, but the truth was California was being robbed. Enron electricity traders were manipulating the market strategies to extract more money from the state. These strategies, most were technically legal, were given catchy names and encouraged new ideas throughout the traders. Enron traders were creating, and then relieving, phantom congestion on California's electricity grid. They were also involved in megawatt laundering, in which Enron bought power in California, resold the power out of the state and then bought the power back and resold it back into California, allowing Enron to avoid price caps meant to secure down costs (4). The electricity traders are also guilty of limiting the supply of energy by asking power plants that provide electricity to California to shut done for a specified period of time so they could take advantage of the shortages. All the while President Bush is refusing to step in to do anything stating the energy crisis will work itself out. Finally, in the summer of 2001 the Federal Energy Regulatory Commission (FERC) stepped in to try and alleviate the energy crisis. FERC

imposed soft price caps, and the entire power market collapsed. Electricity prices decreased and sanity returned to the market because the federal government showed they were willing to intervene, and that was what the market had been waiting for.

Andy Fastow was the CFO of Enron, and with good reason. He was a very powerful and ambitious man; he always got what he wanted no matter what corners he had to cut. Fastow had a very deep interest in Special Purpose Entities (SPE). The definition of an SPE is a business interest formed solely in order to accomplish some specific task or tasks. A business may utilize a special purpose entity for accounting purposes, but these transactions must still adhere to certain regulations (5). Fastow was interested in using SPEs to hide debt and